13Jan

International Expansion and Franchising

Franchising is getting more and more popular as a mode of entrepreneurship. For example, it has become the dominant form of entrepreneurship in the retail sector in the United States. In many industries such as automotive repair, catering, construction, dry cleaning, education, retail merchandise, etc., franchises are replacing independent businesses. In the past decades, except the years of the great recession, hundreds of new franchise systems have been created every year. The International Franchise Association (IFA) is forecasting that the growth rate of franchise businesses – in multiple metrics – will exceed the economy-wide growth, for the sixth consecutive year.


Although overall the outlook is very positive, the franchise landscape differs by region. While the franchise turnover represents 11 percent of GDP in Australia and 5-6 percent in the US, in the EU it represents less than 2 percent of the EU GDP. Studies suggest that. in the EU, the franchise business has exceptional growth opportunities. The 28 countries, with approximately 510 million potential consumers, are quite attractive for many franchisors. Companies worldwide are eager to expand franchise units into Europe.


The motivations that drive franchisors towards international markets are mainly the same as those of non-franchise companies. There is a distinction between internal and external incentives. The main external factors are the saturation of domestic markets, the increased competition, and when franchisor is approached by a foreign company to franchise its business. The internal factors are for example the company-specific resources such as innovative technologies or management capacity, or any other distinguishing aspect(s), which give(s) the company a serious competitive advantage over its peers.


Approximately 80 percent of the 13,000 franchise brands that are present in the EU were developed domestically in one of the current EU countries – the remaining 20 percent mainly has US and Canadian origins. On the other hand, recent study suggests that US franchisors intend to expand into EU in the near future. When it comes to international expansion of European franchisors, they are usually expanding first to the neighboring countries, often along established commercial alliances, for example, UK and Scandinavian countries have close commercial ties, and the export of franchise brands often happens along those relationships.


Though many people presume that getting a franchise rather than launching an individual business is a safer way of entrepreneurship, in fact, in general, buying a franchise license does not reduce the risk of business failure at all. Approximately more than 70 percent of all new franchise systems fail within twelve years; the failure rate is relatively the same across all industries. If we consider that initial length of an average franchise contract is fourteen years, it means that less than one out of four new franchise systems gets through to the end of the contract. While the franchisor as a business may survive the failure of its franchise system, for the franchisee it usually means a business failure as well. Since a failed franchise system carries very little value for the investor, this failure rate means a high level of risk for anyone who buys a franchise license. It is especially true if we consider that some franchisors ask for more than $1 Million, only franchise rights, which is often followed by the purchase of specific assets such as signs, equipment, and training – the value of those specific assets is difficult to recover.


The international context, in Europe, makes the situation more complex. While we generally tend to see the EU as a single market, we cannot overlook the diversity of the European population. Several studies concluded that although there are clusters such as the Midwest (Austria, Belgium, Germany, France, Netherlands), Scandinavia (Denmark, Finland, Sweden), and the Mediterranean (Greece, Italy, Portugal, Spain), in which the countries have a certain level of homogeneity, the European Union is very far from being a single homogeneous market. It means several differences among the different countries/regions, starting from different taste preferences through different legislations to different purchasing power of the disposable income. This phenomenon means that a franchisor might need to make some or significant changes in its system even when it expands to a neighboring country.


A study of 500 US franchisors, comparing domestic and international franchises actually found that going international, in many cases, is challenging the existing processes, product(s), operation, etc. because it requires products/services modifications, different training programs for franchisees, adaptations to legal regulations, managing foreign exchange risks, etc. Therefore, it seems reasonable to apply a so called "test period” when an international franchise system is developed. In this period of six months to two years, through a company owned outlet or working closely with the franchisee, the system can be adapted to the local needs, before selling any licenses. The test period also should be used to develop capabilities that are crucial for successful international operation.


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